|By Matein Khalid|
This is the last thing the GCC’s property, tourism, retail and bank funding markets need as a higher US dollar both imports deflation risk, pressures oil prices and sends a big chill into the regional business cycle. I expect the Federal Reserve will now be forced to hike interest rates at least three or even four times in 2017. This means the three month Emirates Interbank Offered Rate (EIBOR) could rise to at least 2.5% in the next twelve months. As bank funding costs rise, bank loan growth will decelerate – even as the cost of credit (loan pricing) surges. This is hugely negative for property markets in the GCC. Note that real estate shares have fallen 15 – 20% in the US, Europe and Asia in the past three months. I have never seen such a draconian, swift tightening in the bond market in my career in the capital markets as I witnessed last week.
This “Trump tantrum” has raised the cost of capital for the leveraged economies of the GCC even as they experience epic budget deficits, fiscal austerity, a banking credit crunch and an economic slowdown. I did not buy the Saudi Arabian sovereign debt new issue because the pricing was too tight and I was not comfortable with the ten year US Treasury note at 1.75%. Now the ten year US Treasury note yield has spiked to 2.13% and owners of long duration bonds and property (the ultimate long duration, illiquid assets) will face horrific losses in the next year.
The rise in the US dollar also amplifies deflation risk in the GCC since its currencies are pegged to the greenback. This means a fall in tourism, retail sales, bank loan growth and investment in property. Modi’s currency crackdown, the plunge in the Russian rouble, Euro and British pound have all hit offshore financial flows into the GCC property markets. It is entirely possible that higher interest rates push Europe into recession since EU inflation is so far below the ECB inflation target. With election risk in Germany and France, with Italy’s referendum a potential game changer, I would not be surprised if the Old World slips into recession in 2017. This could mean the world is on the precipice of another oil crash since Trump’s threat to reinstate economic sanctions on Iran could end an OPEC oil deal in Vienna. In any case, Trump will repeal regulations that inhibit fracking in the US and trigger an oil drilling boom in the West Texan Permian Basin. This means the US could well add another 2 million barrels a day in shale output to glutted global markets by 2018.
As the Federal Reserve raises rates in December and in 2017, three month LIBOR could well rise to 2%. This will mean a dramatic rise in the funding cost of UAE banks, which already face credit stress, a rise in non-performing loans and corporates with insufficient cash flow to service debt. The sharp rise in the cost of mortgages will eviscerate loan demand in a property market that cannot remotely absorb current supply. Offplan property developers will be the worst hit but capital values will contract dramatically as the cost of borrowing surges. Prices can well fall at least 20-25% in 2017 in the third year of the property bear market as the credit cycle turns uglier once Trump takes office next January.
Trump’s foreign policy could also have a seismic impact on the international relations, economies and the financial markets of the GCC. Trump’s promise to roll back Obama’s Iran nuclear deal and reinstate economic sanctions on Iran means no trading boom or “peace dividend” in the Gulf. Trump’s campaign promise to move the US Embassy in Tel Aviv to Jerusalem could ignite another popular Palestinian revolt in the Occupied Territories. Trump’s plan to appease Putin and lift sanctions on the Kremlin will increase Russian dominance in Syria. Trump has no interest in nation building in the failed states of the Arab world, from Libya to Iraq to Yemen, beyond his promise to “exterminate” ISIS. The endgame? A more violent, unstable Middle East.
Currencies – A post-election bloodbath in emerging markets currencies!
Emerging markets face a new paradigm with the Trump win. The Mexican-peso is the worst victim of Trump, down 14% since the election. The peso can well fall to 23 against the US dollar by early 2017. As Porfirio Díaz, a Mexican dictator once lamented, “poor Mexico. So far from God, so close to the United States”. After all, 80% of Mexican exports go to Gringoland and 12 million Mexicans work in the colossus across the Rio Grande. If Trump tries to restrict or repeal NAFTA or crack down on Chicano migrants, the Mexican peso will plummet in value against global currencies. In any case, the rise in US Treasury bond yields, the risk of a sovereign debt downgrade, pressures on Pemex and oil prices could fall below $40 if there is no OPEC output cut deal in Vienna on November 30.
I have used the Indian rupee as an ideal high carry currency against sterling (the Mother India trade). Modi’s crackdown on India’s $270 billion black money hoard makes me even more bullish on the rupee’s relative prospects (to sterling! The jewel in the crown is the rupee, not the quid, Ganga Din!) because it will boost liquidity in the Indian banking system and expand the tax base. After all, it is surreal that only 13 million Indians paid income taxes in 2015, 1% of the population. Despite US dollar strength, the Indian rupee has been one of the most resilient emerging market currencies since August. This is a testament to the offshore fund tsunami headed for Dalal Street. As Indian bank deposits soar, (note the Indian bank shares go ballistic in Nifty!), I expect Indian G-Sec yields will continue to fall while RBI Governor Urjit Patel uses lower inflation to cut the repo rate again in early 2017.
Indian ten year government securities (G-Secs), recommended here at a 7.50% yield in early 2015, are a winner from Modi’s rupee move. The rise in banking sector deposits and a steep fall in property prices could combine to give India a mild deflation shock. Imports will fall, a boost to India’s current account deficit. As India’s tax base expands, a sovereign credit upgrade and a new capex cycle begins. The ten year Indian local government bond yield, 6.70% now, could well fall to 6.20% in the next six months. The Indian rupee could well retest the “Modi high” of 58 in 2017, though the King Dollar trend could pressure it to 68 in the next three months. As Modi and Trump both proved this week, big money is made when white replaces black!
The post Vienna fall in crude oil and the surge in the US Dollar Index is catastrophic for the Russian rouble. Yet the caveat is that Donald Trump wants a diplomatic rapprochement with Russia that could include an end to post Crimea sanctions on the Kremlin’s banks and energy companies. While it is still premature to call the geopolitics, the Russian rouble can trade in a 64 – 70 range for now.
The Turkish lira was 2.90 just before July’s failed coup attempt against Erdogan’s AKP government. Since then, the Turkish government has launched an anti-Gulenist purge that cost 100,000 military officers, judges, educators and bureaucrats their jobs. Turkey is embroiled in a renewed war with the Kurdish secessionist PKK and checkmated by Russia in Syria. The IMF has slashed GDP growth estimates. The higher US dollar and multiple Fed tightening will trigger an offshore capital exodus from the Turkish lira money market. The current account deficit could surge to 7% of GDP and the Turkish lira fall to 3.80 against the US dollar by next June.
Investors slammed emerging markets worldwide on Friday. Argentina, South Africa and Indonesia fell 4%. This is natural given the spike in the US Treasury bond yield to 2.15%. Mr. Market, unlike Mrs. Yellen, has no time for glacial interest rate hikes and dovish jawboning. Global liquidity will tighten as US interest rates and the US dollar both soar, Count Dracula’s cross in sunlight to emerging markets. This was the reason the Brazilian Real plunged 5% in a single session, the worst since Dilma’s Petrobras scandal broke. Yet if Trump ignites a trade war with China, all bets are off. The world could wake up to a 20% devaluation of the Chinese yuan and another 2008 scale global financial crash.
Market View – The fabulous bull run in US bank shares
Financial shares rose 10 – 12% last week after Trump won the election. Trumps has promised to rollback the regulations of the Obama era. Trump will probably fire the director of the Consumer Finance Protection Board and scrap the Department of Labour fiduciary rule. He judges Dodd Frank, the most crisis bank reform, “a disaster”. His plans to increase infrastructure spending has led to a spike in interest rates. This has led to surge in the valuation of money centre banks, asset managers, life insurers and even asset managers on Wall Street. The Republican Party never embraced Dodd Frank or draconian rules on banking. Now Trump could well inaugurate a new era of financial deregulation to boost bank loan growth.
Trump has made no secret about his plans for fiscal stimulus or his frustration with the dovish Fed chair Janet Yellen. This means a high inflation risk premium for US Treasury debt. and a sharply steeper government bond yield curve. Trump has a mandate for tax reform from the Republican Party, a key pillar of Paul Ryan’s blueprint. His economic growth policy package is hugely bullish for US regional banks as it will goose balance sheet growth and returns on equity. The best positioned banks are those who will benefit most from a rollback of the consumer banking regulatory regime, have a high degree of operating/expense leverage and a liquid, asset sensitive balance sheet. Trump might not “make America great” but he has definitely made investing in Wells Fargo great as it shares have soared 11% to 51 as I write. The Californian banking Cinderella finally found her Prince Charming or rather Prince Trumpkin!
The only thing more surreal than Donald Trump’s election was the American stock market’s wildly bullish reaction to his upset win. The world’s biggest economy could, if Trump’s campaign promises become policy, impose tariffs on China and label Beijing a “currency manipulator”, repeal NAFTA, build a wall across the Mexican border, “take” Iraq’s oil, exit from NATO if Europe does not pay the bills for its own defense, scrap Obama’s Iran nuclear deal, fire the Fed chairwoman and punish U.S. companies who “offshore” manufacturing jobs. Not exactly a formula for a bull market!
Yet Wall Street has turned bullish on Trump’s plan to lower corporate taxes, repeal financial regulation and boost infrastructure spending by $500 billion. This means a higher Uncle Sam budget deficit and higher inflation. Sectors that benefit from higher economic growth – copper, steel, construction materials, transport, industrial conglomerates, banks, engineering and machinery, were bid up by investors on Wall Street.
Yet Trumpnomics also means sharply higher US interest rates and at least three Federal Reserve rate hikes in 2017. So it triggered a surge in the US dollar, a meltdown in the US Treasury (and global government) bond markets and a stunning $80 an ounce fall in the price of gold.
The post-Lehman era of easy money and rock bottom interest rates is over. The post 1945 US dominated international trading order is threatened by Trump’s economic populism and protectionist rhetoric. Trump’s threat are not toothless since the Republicans now control the House and the Senate.
Economist calculate that Trump’s pro-growth policies will add $10 extra EPS to the S&P 500 next year but also raise Uncle Sam’s debt by 25% in the next four years. As King dollar soars and the world bond market crashes, the risk of capital markets catastrophe has begun to rise. King Dollar will make protectionist policies inevitable as Trump seeks to protect U.S manufacturing jobs in the Rust Belt. China will then retaliate and the world will be plunged into a trade war that is a disaster for emerging markets. King Dollar, a bond market meltdown and a trade war defined Ronald Reagan’s first three years in the Oval Office. The early 1980’s also coincided with the worst global economic recession since the Great Depression.
Wall Street has concluded that Trump will implement Reaganomics for the Digital Age. I believe this bullish verdict is too premature. The wild market swings last week once again thought us that the pendulum of greed and fear swings at the speed of light.
